So if there really is a housing bubble then how do you profit from it?

[CarreraS2]

Originally posted by alf
I do not think that the RE market will pop like the dot com; prices will stabilize and higher end homes will generally experience a greater decline than lower priced homes.

My reasoning...
-Homes are not as liquid as stocks, i could not sell a home in 2 mins like i could stock.
-Homes are not created on hype, there is intrinsic value in land and structures.
-People will still need to live somewhere.
-Financial institutions that made high risk/levereaged loans will feel the biggest pains.

EVERY single one of those factors was true during the last major decline.

For example, each of those factors was true in So. Cal. in 1989.

But that didn't stop the 40% decline in the real estate value in the early 90s.

But, I know, "this time will be different."

[alf]

Right but how long did it take to happen? The bubble did not pop as rapidly as the dot com bubble did it? And, it recovered eventually.

[turbo6bar]

Methinks you're taking the word "pop" too literally.

This real estate boom dwarfs anything else in history. Any person should have great difficulty predicting what will happen, when or why. One of the significant variables is player sentiment. It is hard to predict the attitudes of the players. Greed is strong, but fear is usually stronger.

The absolute best case scenario I see is a flattening in the market, with incomes and inflation rising to match real estate levels. This would imply a flat RE market for 5, 10, maybe even 15 years.

I don't think anyone can argue and prove a national appreciation rate of 12% is perfectly normal and based upon a healthy backdrop.

[Rodeo]

There's a story in our local paper today about the boom in coastal real estate prices in Rhode Island. One couple bought a home less than 10 years ago for $350k. Sold it recently for $3.2 Million. Many similar stories .... I think when interest rates go up, we are in for a hard landing. Hope I'm wrong.

[JavaBrewer]

Originally posted by Rodeo
There's a story in our local paper today about the boom in coastal real estate prices in Rhode Island. One couple bought a home less than 10 years ago for $350k. Sold it recently for $3.2 Million. Many similar stories .... I think when interest rates go up, we are in for a hard landing. Hope I'm wrong.

Location location location. Never been to RI but I would bet the farm that most RE in that area has not appreciated similarly. 3 blocks away from where I live a slightly smaller house with same bedroom/bath count sells for 45% of what ours would sell for today. The difference is that they are not on top of the hill with views.

[CamB]

Originally posted by alf
My reasoning...
-Homes are not as liquid as stocks, i could not sell a home in 2 mins like i could stock.
-Homes are not created on hype, there is intrinsic value in land and structures.
-People will still need to live somewhere.
-Financial institutions that made high risk/levereaged loans will feel the biggest pains.

Answers, as I see it.

1) The illiquidity of homes has driven the prices up faster than it should thus far - no reason the same impact can't cause prices to overshoot on the way down too. Because relatively few houses (compared to the actual stock) sell, it doesn't take much to push the price up (or down) in a way which doesn't reflect what I would refer to as fundamentals (see next answer).

2) There is intrinsic value to land and structures - in particular the cost of building is one component and the scarcity of land is the other. However, affordability and/or return on investment is the third factor. There is not unlimited funding chasing houses - IMHO, in the medium term they must be related to income levels. They sure as hell don't now.

3) So people do have to live somewhere - the question is whether spending 50% plus of their income on housing is sustainable or not - history suggests not.

4) Financial institutions have felt pain before, but quite frankly I find their behaviour at the moment extraordinary. They are bordering on risk lovin'.

[alf]

Originally posted by turbo6bar
Methinks you're taking the word "pop" too literally.

This real estate boom dwarfs anything else in history. Any person should have great difficulty predicting what will happen, when or why. One of the significant variables is player sentiment. It is hard to predict the attitudes of the players. Greed is strong, but fear is usually stronger.

The absolute best case scenario I see is a flattening in the market, with incomes and inflation rising to match real estate levels. This would imply a flat RE market for 5, 10, maybe even 15 years.

I don't think anyone can argue and prove a national appreciation rate of 12% is perfectly normal and based upon a healthy backdrop.

I agree here that the RE market is over heated at the moment and am optimistic that the market will flatten out instead of a rapid decline in value that we saw in the dot com market, as it was compared to.

Another factor that will determine how much of a correction we will see is how levered homes are. If a large majority of homes are owner occupied with low Debt/Equity ratios then the landing will be softer. If the opposite is true then it will be hard.

A soft landing could be engineered with gradual interest rate correction and better lending regulations.

But back to how to make some $$ from the eventual correction...i still think that getting the equity out in the form of a fixed interest HELOC and putting it into other assets that are appreciating more than the cost of your loan is the way to go if you are house rich and still want to live where you are.

alf

[turbo6bar]

Quick review of Home Equity Loan rates at bankrate.com: 6.9-7.5%

Where will you put the cash to ensure a decent spread?

Profit from the bubble: pay off your debts and wait for all asset classes to readjust. That is, unless someone knows an asset class that's undervalued. Don't say early 911s. I won't believe you.

[Rodeo]

I don't think a home equity loan, which typically has a floating rate, is the way to go. A floating rate is not going to do anything for you in a high rate environment, which is what I expect will happen sooner rather than later.

I’d do a 30 year cash out refinance at between 5.5-6.5% right now. Sit on the cash for a year or so, a CD, or bonds, or T-Bills. When long term rates go up, even a Certificate of Deposit will put you in the black.

A long-term, low interest, cash out refinance right now is the next best thing to cashing in by selling. As long as you are not stupid and lose the principal, the worst case is rates won’t go up and you pay it back in a couple of years, with a 2-3 point loss.

What do the experts out there think of this strategy?

[CamB]

Originally posted by alf
Another factor that will determine how much of a correction we will see is how levered homes are. If a large majority of homes are owner occupied with low Debt/Equity ratios then the landing will be softer. If the opposite is true then it will be hard.

It doesn't necessarily work that way - the price is set by the marginal seller/buyer. If there are people defaulting (ie, the most leveraged ones) then the price at which their houses sell is what determines the prevailing market price.

If there isn't a big enough pool of potential buyers at moderate prices in that circumstance then the price could drop significantly, no matter how many people are owner-occupiers with sensible debt levels.

[EdT82SC]

Originally posted by Rodeo
I don't think a home equity loan, which typically has a floating rate, is the way to go. A floating rate is not going to do anything for you in a high rate environment, which is what I expect will happen sooner rather than later.

I’d do a 30 year cash out refinance at between 5.5-6.5% right now. Sit on the cash for a year or so, a CD, or bonds, or T-Bills. When long term rates go up, even a Certificate of Deposit will put you in the black.

A long-term, low interest, cash out refinance right now is the next best thing to cashing in by selling. As long as you are not stupid and lose the principal, the worst case is rates won’t go up and you pay it back in a couple of years, with a 2-3 point loss.

What do the experts out there think of this strategy?

I'm not an expert, but I don't like it. If you get a HELOC you don't pay anthing until you use it. Generally it takes several years for the market to drop. So you get your HELOC now, and wait. It costs you $0. After a the market has dropped the interest rates will then start to drop so your HELOC starts to get cheaper too.

Cash out, and you start paying right now. I'd rather save more money.

[jyl]

I just heard an interesting story. A colleague sold his house in Moraga (very expensive area of the SF Bay Area) and bought a 4,000 sq ft house in Carmel Valley (I think this is a nice area in the San Diego region). He told he paid $450,000 under asking, that houses in that area have been rolling over significantly, that some people have been taking houses off the market for lack of bids, and that other people who have to sell are half-panicking. Any input on this? Is what he is telling me true?

[CarreraS2]

I've read some things about rumblings in San Diego. Don't know if it's true or not, as I'm not personally familiar with SD real estate.

I do think that people are looking to SD for the first signs of weakness, as it appears that SD was the first area in So. Cal. to begin taking off. So it is the most "mature" market and theoretically should signal the downturn.

[jyl]

http://www.signonsandiego.com/news/metro/20050914-9999-1n14housing.html

Lead paragraph:

"San Diego County, which set the pace for Southern California's rapid climb in home prices, could be leading the region in a slowing of appreciation that has brought prices to just above last year's levels."

[techweenie]

Originally posted by jyl
I just heard an interesting story. A colleague sold his house in Moraga (very expensive area of the SF Bay Area) and bought a 4,000 sq ft house in Carmel Valley (I think this is a nice area in the San Diego region). He told he paid $450,000 under asking, that houses in that area have been rolling over significantly, that some people have been taking houses off the market for lack of bids, and that other people who have to sell are half-panicking. Any input on this? Is what he is telling me true?

There have been stories like that for over a year. I personally know of houses that sold several hundred K under asking, but then they are multi-million dollar houses with insane asking prices in the first place. I watched a developer turn down a $7 million cash offer, hoping to be near $8 million, then later relist -- sliding all the way to $5.9 million, as the market cooled. That was over a span of 6-7 months(!!!)

But these are isolated areas. Overall, the market is not behaving that way... yet.

BTW, the Carmel Valley is southeast of Carmel, near Monterey/Pebble Beach.

[jyl]

Originally posted by techweenie
BTW, the Carmel Valley is southeast of Carmel, near Monterey/Pebble Beach.

I heard the town's name wrong, then. This was definitely in the San Diego area, he says he now lives one town over from Del Mar.

Anyway, on the original topic, here's an article from the Saturday Wall Street Journal. I haven't read the whole thing but thought it was appropriate for the thread.

"New Tools to Hedge
Your Home

Exotic Investment Products
Target Anxious Owners
Eager to Lock In Their Gains
By JAMES R. HAGERTY
Staff Reporter of THE WALL STREET JOURNAL
September 17, 2005; Page B1

Once, a home was a castle. Now it is looking more like Fort Knox -- a pile of money in need of protection.

Amid warnings from economists that real-estate values in some parts of the country may drop eventually, there is a nascent movement to offer new investment products designed partly to hedge against falling property prices. The goal: Offer limited protection against the risk of riding real-estate prices back down again after the record run-up in recent years.

In recent months, Merrill Lynch & Co. and other investment banks have started offering investment products that will rise in value if a basket of housing-related stocks declines. Already, nearly $400 million of these investments have been sold, according to Daniel Carrigan, vice president for new-product development at the Philadelphia Stock Exchange.

The Chicago Mercantile Exchange also is preparing to announce plans to introduce in the second quarter of next year futures contracts based on home prices in each of 10 cities. It will also offer a composite contract covering all 10 cities. That plan follows the introduction last May by HedgeStreet Inc., based in San Mateo, Calif., of financial contracts called Hedgelets that let investors bet on a rise or a fall in home prices in six individual cities.

Strategies like these are far from foolproof, however. Derivative products like these can be complicated and risky, and none of them offers a perfect hedge against the risk that the value of any individual home will fall. But they do provide a new strategy for people worried about an eventual slump in housing.

For people who shy away from the complexities of derivatives, there are an array of other options for shielding home equity. These strategies range from the straightforward -- for example, locking in a fixed-rate mortgage while rates are still low -- to riskier approaches, including perhaps becoming a renter for a while.

The stakes are high for homeowners: In the past five years, home prices nationwide have jumped an average of 50%. That has bulked up the net worth of many Americans but also left a much larger proportion of their wealth locked up in real estate.

Since 1999, Americans' equity in their homes has soared 68%, to nearly $10 trillion in this year's first quarter, according to Federal Reserve data. During the same time, the value of stocks and mutual-fund shares held by households and nonprofit groups has declined 18% and also equals about $10 trillion.

Tom Atkin, a 58-year-old marketing consultant, nine years ago paid about $335,000 for a three-bedroom ranch house in the San Fernando Valley near Los Angeles. He figures it is now valued at well over $1 million, and has thought about selling his home now while the market is hot and moving to a less-expensive area. One problem, he says: "I wouldn't know where to put all the cash [from the sale] that would earn as good a return."

While many economists warn that prices in some regions eventually could level off or fall, the housing market has thrown off mixed signals in recent weeks. Inventories of unsold homes are up sharply in some areas, including Boston and the Virginia suburbs of Washington, suggesting that buyers have become more cautious and are taking their time. Another indicator of concern is that houses have become hard for most people to afford in some places. A new study by Carl Haacke, a consultant who was a White House economics aide in the Clinton administration, found that nearly a third of homeowners in Miami, for instance, are paying more than 40% of their incomes in housing costs.


Yet at the same time, there are optimistic signals. Applications for mortgages by prospective home buyers have rebounded in the past two weeks after slumping on a seasonally adjusted basis during most of the summer. And prices are continuing to rise steeply in much of the country, though that only adds to worries that any eventual decline might be more severe.

While it is impossible to protect yourself entirely from the possibility of a decline in home prices, there are strategies for shielding yourself against at least part of the risk. Here is a sampling:

Dabble in derivatives: There are a variety of ways to use the financial markets to provide a limited hedge against a weak housing market. All of them are far from perfect, and most would be too complicated or risky for the average homeowner.

Among the newest twists in this area are the housing-related notes recently offered by Merrill and other investment banks. Merrill's Protected Bear Notes, introduced this past spring, offer a way to bet on a decline over the next eight years in the Philadelphia exchange's Housing Sector index, which is based on the stock prices of 21 companies involved in home building or closely related businesses. The notes will gain in value if that index declines.

Several other firms, including Morgan Stanley and Royal Bank of Canada, have offered similar notes. ABN Amro Holding NV, the Dutch banking concern, has offered a version of these notes to investors outside the U.S.

While these notes offer a way to profit from a slump in the housing industry, they aren't an ideal hedge. House prices in certain areas could fall or rise based on such factors as the health of the local job market, regardless of how national home builders are performing.

The Chicago Mercantile Exchange is focusing more directly on house prices. It recently reached an agreement to launch housing futures contracts devised by Macro Securities Research LLC, Morristown, N.J. The owners of Macro include a Yale economics professor, Robert J. Shiller, who is known for his gloomy views on the housing market. The futures will be based on indexes of prices in 10 large U.S. metropolitan areas, says Sam Masucci, chief executive of Macro. "We believe there is tremendous interest from people who are interested in hedging home prices," he says.

HedgeStreet, whose Web site is www.hedgestreet.com, has a jump on the Chicago Merc. The firm offers its Hedgelets as a way to allow buyers to bet on a rise or a fall in home prices in Chicago, Los Angeles, Miami, New York, San Diego and San Francisco.

For instance, the site on a recent day offered the possibility of betting that the median San Diego home price at the end of the current quarter will be either above or below $643,000, compared with about $605,000 in the second quarter, as calculated by the National Association of Realtors. If a client correctly bet $1,000 that the third-quarter price will be lower than $643,000 when it is reported in mid-November, the Hedgelet would be valued at $1,140, or 14% more than the amount invested. However, if the price rose above $643,000, that Hedgelet would be worthless.

There is little trading in these contracts so far. Also, the contracts expire quarterly, so it is impossible to buy a long-term hedge. "It's small but growing steadily," says Russell Andersson, a vice president and co-founder of HedgeStreet.

Jonathan Reiss, a financial consultant in New York, says he has been experimenting with housing Hedgelets and has made some money by betting on a weaker market. Mr. Reiss, who owns a home in Manhattan, says the Hedgelet market is too illiquid to allow any real hedging.

Switch to a fixed-rate loan: Over the past few years, more Americans have been taking out adjustable-rate mortgages, which offer lower rates but expose borrowers to the risk that they will have to pay much higher rates later on. So far this year, around a third of all applications for home loans have involved adjustable rates, though that proportion has been falling in recent weeks.

Many financial planners say it is time to ditch those adjustables and lock into long-term fixed-rate loans, taking advantage of fixed rates of around 5.75%, very low by historical standards.

[continued in next post]"

[jyl]

[continued from prior post]
"When the general level of interest rates goes up, so do payments on adjustable-rate loans. "You kind of put yourself in a vise if you have an adjustable-rate mortgage and you see your property value going down while your mortgage payments are going up," says Michael Maloon, a planner in San Ramon, Calif.

Even so, adjustable-rate loans are cheaper, at least in the short run, and can make sense for people who know they are going to move within a few years.

Make sure you have cash reserves or a credit line. Financial planners recommend that homeowners make sure they could keep paying their mortgage even if they lose their jobs or suddenly can't work for health reasons. "You need something between you and the equity in your house," says Phil Cook of Cook & Associates in Torrance, Calif.

That is vital because in a weak housing market you may need lots of time to find a buyer for your home. If you are unable to meet monthly payments, you would have the choice of defaulting (and destroying your credit rating) or slashing the price to fire-sale levels.

Having enough savings would let you keep paying the mortgage while waiting for a buyer. An alternative for those without much savings is to take out a home-equity line of credit now, says Charlie Fitzgerald, a financial planner in Maitland, Fla. That provides a standby loan that could be used temporarily to meet mortgage payments in a pinch.

Sell some property. People who own second homes or rental units might consider selling some of them while prices are high. Seok H. Jo, a financial planner in Los Angeles, says some wealthy clients are cashing out of rental properties and second homes, putting the money into municipal bonds or large-cap stocks instead.

Bill and Linda Cronin were so worried about the danger of a housing collapse that they recently sold their primary residence in Lake Helen, Fla. -- and moved into a recreational vehicle, which they are using to tour the U.S. Mr. Cronin, 58, a retired management consultant, figures the housing boom "is going to come to a screeching halt eventually."

Still, the Cronins have hedged against the risk that house prices will keep rising: They still own a rental home in New Smyrna Beach, Fla.

Another tactic: If you live in a frothy housing market and expect to move within a year or so, it may be worthwhile to consider selling now and renting for a few months. Last year Dean Baker, a Washington economist who is bearish on U.S. real-estate prices, decided to take profits on the two-bedroom condominium he and his wife owned in Washington's Adams Morgan neighborhood. Having bought the condo for about $160,000 in 1997, Mr. Baker says, they sold it for nearly $450,000 in May 2004. The couple now live in an apartment nearby, costing $2,250 a month in rent.

Since they sold, Mr. Baker concedes, the market value of his old condo probably has gone up even further. But he says he is happy with his decision. "Realistically," he says, "you're not going to be able to pick the exact top" of the market.
"

[turbo6bar]

MA inventory up 40% year over year. 7.5 month supply

Inventories in SoCal counties

Phoenix inventory is up 65% in the last two months: from 10k to 17k.

San Diego strong, but showing some weakness

I don't think we can draw any conclusions until a few more months roll by, but everything I've seen points to higher inventories. I think most of the inventory is from those trying to jump ship. Prices won't go down unless these folks need to sell.

[turbo6bar]

Not directly related to this thread, but interesting nevertheless.

Housing prices can go down

Notice the numbers are not adjusted for inflation.

[JavaBrewer]

Originally posted by jyl
I heard the town's name wrong, then. This was definitely in the San Diego area, he says he now lives one town over from Del Mar.

Carmel Valley is just North of Scripps Ranch on the I-15. "Just one town over from Del Mar" is kinda optimistic ,it's more like 8 miles East of Del Mar. The area is still very desireable so I find the $450K under asking questionable unless it was a multi $M property that was overpriced to begin with. Majority of homes in Carmel Valley are 5-10 years old and range from $450K-$1.2M.